Heisenberg’s Friends

‘Rational Exuberance’ – Which Is An Oxymoron

Net % saying equities overvalued at record high (48%); yet cash levels are falling; this is a sign of “irrational exuberance”.

That’s from the color that accompanied BofAML’s latest global fund manager survey and the reference is to this chart:

Everyone thinks stocks are overvalued, but at the same time, no one is raising cash. One way to interpret that is to call it “irrational exuberance” or, as we put it, you folks “are a silly bunch.”

Or maybe not. Maybe this is “rational” exuberance. That’s the way Barclays prefers to look at things – at least until H2 2018.

In their sprawling global outlook piece, the bank makes what has now become the consensus argument. Namely that decent growth set against a backdrop of subdued (but not terrible) inflation creates what amounts to a “Goldilocks” environment for risk assets and absent a significant uptick in price pressures that force central banks to withdraw support faster than anyone anticipates, an epochal shift in the prevailing dynamic is unlikely.

“It has become progressively difficult to say something new in a macro environment that has been so stable and risk-supportive for several quarters,” Barclays writes.

They’re right. Unfortunately, that doesn’t obviate the need for people to pontificate because when you are a macro guy/gal, pontificating is your job. And by God, Barclays does some pontificating; 95 pages worth, to be exact.

It’s Friday, which means we’re probably talking to algos at this point and thus there’s little utility in trying to “go deep” (as it were). So instead, here are Barclays’ bullet points which flesh out what they call “rational exuberance.”

Via Barclays

Rational Exuberance

The global expansion remains broad-based and in good health. The US was the upside surprise in Q3, but the euro area, Japan and China are all growing at or above consensus. The synchronized upswing is creating a virtuous circle, with strong global demand boosting US trade and inventories in Q3. We expect the world economy to grow at 4% in 2018, with upside risk if the US enacts significant tax reform.

Despite the recent commodity breakout, we see no signs that global inflation pressures pose a risk, either to the expansion or to markets. Wages, inflation and breakevens remain stubbornly low in most large economies. Y/y core inflation in Japan and the euro area will struggle to rise above 0.5% and 1.4%, respectively, even by the end of 2018. In the US, we forecast core PCE inflation to be well below the Fed’s 2% target across 2018.

Investors now have more clarity on central bank policy and personnel. The ECB has extended QE until September 2018 and kept it open-ended; arguably, ECB and Fed balance sheet policy is now priced into markets. The nomination of Jerome Powell as the next Fed chair suggests monetary policy continuity in the US. The same is true in Japan after the Abe coalition’s landslide election victory.

Investor concerns about coordinated tightening might pick up in H2 18 if the global output gap closes further and if wage pressures finally surface. But central banks are unlikely to pose a risk to markets in the first half.

Elevated valuations in most risk assets suggest less robust but positive future returns, not an imminent correction. We still like equities over fixed income, expect bond markets to stay range-bound, and expect the USD to resume its medium-term weakening trend after there is clarity on tax legislation.

The fundamentals – strong growth, mediocre inflation, higher commodity prices and a steady China – are very positive for EM assets. But with term premia depressed across the globe, we recommend real assets in EM space, such as equities and real interest rates, instead of local currency bond markets.

One thing worth noting: the term “rational exuberance” is to a certain extent an oxymoron.